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One Size Does Not Fit All When Investing

Many investors think that “conservative” means tilting more towards bonds and fixed income.

I disagree.

That’s because one size does not fit all. An asset mix of 30% stocks and 70% bonds isn’t conservative if all the stocks are concentrated in volatile sectors with a history of big gains and big losses. Conversely, you aren’t being terribly aggressive with 70% stocks if they are all of the Peter Lynch stalwart variety.

Also, tilting towards bonds has been overly conservative, if you plowed your money into bonds after the Fed’s long-running quantitative easing. You’ve been making next to nothing in interest, and your bond prices haven’t gone anywhere until just recently. In fact, inflation has been eating away at the value of those bonds.

A portfolio that is overweighted in value stocks will also have less risk than one overweighted in growth stocks. The problem with growth stocks is that, while properly chosen ones will outperform the market and deliver terrific returns, you can easily overpay for growth and find yourself getting clobbered if growth suddenly flags. Look at just about any restaurant or clothing brand stock.

Speaking of Peter Lynch, the famous Fidelity fund manager, remember what he said is the best investing advice he could offer? Buy what you know. Let’s take that in context with risk.

Consider this: you are an expert in widgets. You know everything about the sector. You know management, lobbyists, lawyers, policymakers, the market for widgets, innovations in the sector – you know everything. Investing in widgets involves far less risk for you than it does for another investor who is widget-ignorant. Personal knowledge reduces risk, because you have more foresight as to what can go wrong, and when something is overvalued.

For example, I was a Hollywood TV writer/producer for 12 years. Even after I left, I maintained relationships with people I knew. I not only get information from writers and actors in the trenches of Hollywood, and therefore get insight into which operations are being run well, but from studio executives and agents. I have friends who cut film trailers, so I get advance word if a film will be any good. I know production people who will tell me if a TV show or film is on time or off the rails. I know how audiences respond to content. I can distinguish between Netflix’s strategy and that of HBO.

I also happen to be an expert in credit, especially consumer credit. As with the widget example, I know all those same people. I know how consumers behave. I know when someone is more likely to pawn something than take out a payday loan. I was the first US journalist to cover payday lending, which is why hedge funds and private equity funds ask me to consult for them.

I’m not saying this to brag, but to point out that personal expertise matters. It reduces risk.

Value vs. Growth

As you can see, value stocks outperformed growth stocks in all categories during this 26-year period. Large cap value stocks had an annualized return that 0.43% higher, which translated into an additional $9,200 of returns from a $10,000 investment. Mid-cap value outperformed by 0.77%, for a $22,100 improvement. Small-cap value stock outperformed by 1.87%, which led to a massive difference of $44,800.

Stealth Inflation

There’s one other consideration that nobody pays attention to: inflation. I know what you’re thinking, that inflation is only about 3%.

That’s not true. I have terrible news. It’s closer to 10%.

The Chapwood Index is a real-time inflation monitor, created by my friend and colleague, Ed Butowsky, a wealth manager in Dallas. As you can see, it reports on the actual prices of 500 items that most Americans buy with their after-tax money. “No gimmicks, no alterations, no seasonal adjustments”.

And most cities are seeing inflation at or above 10% per year!

I call this “stealth inflation” because nobody really sees it unless they are paying attention. Have you noticed that packages of pretzels and chips and snacks contain less than they used to, yet their prices are rising? You are getting hit with a double dose of inflation. Those 16-oz packages may be only 13-oz. now. Who would produce a 14.5-oz can of diced tomatoes? Why not 16-oz? That orange juice in my refrigerator is 59-oz. What happened to 64 oz?

By knocking off 5-oz of product, inflation for orange juice rises to 7.8%. That 13-oz package of pretzels translates to 20% inflation. These don’t even include price increases.

That’s why, if you’ve been sitting on large stakes of fixed income securities, you may have a problem brewing down the line and you may not notice it until it’s too late.

Regrettably, that means we must push further out on equity curve to keep up with inflation. That doesn’t mean taking on a ton of risk. It means you have to be prudent with what you purchase.

One size does not fit all. You must determine what level of risk YOU are comfortable with.

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